There are plenty of stereotypes of musicians. One is not having money. At least until they hit it big, and then make millions.
The reality is, most musicians are somewhere in between making millions on tour and playing on (and maybe living in) the streets. Making a living from music is hard and unique work, and those who do it have a different set of personal and business financial issues to deal with (8 Topics for Musicians…Part I).
A retirement plan is one of those boring but necessary financial planning elements that most people assume musicians are lacking in (we can assume they are lacking as 1/3 all Americans already have no retirement savings ). Take a moment as a musician and look at one of your most crucial tools for funding the biggest expense of your life – the IRA.
Why Do IRA’s Matter to Musicians?
IRA’s are very important for musicians and artists, especially compared to the general population. This is because most musicians are working as a self-employed business, making money though gigs, giving lessons, and odd jobs here and there.
Great, you’re your own person! The man can’t make you come in at 8am, or stay in the office late for overtime. You don’t have to worry about a jerk boss.
You also don’t have to worry about checking out how much free money was put into your 401k; because you don’t have one.
Yup, I said free money. Well, pretty much. If you work at one of those Fortune 500 companies (and lot of the middle sized and smaller ones too), you will often get a matching bonus on your 401k contributions. It’s a way for big companies to give out extra compensation while getting some nice tax benefits.
For example, a 401k may be designed so that if you contribute 3% of your salary to your retirement account, then the company would “match” that 3%. If you make $100,000 a year, and put away 3% or $3,000 (or more), the company would put another $3,000 into that 401k for you. If you just left it all in cash, you still essentially made a 100% return on your money! $3,000 of your money plus the $3,000 bonus is $6,000.
If you don’t fully understand that, don’t worry, no one is going to be giving you money free money.
As a freelancer or small business owner you don’t have a retirement plan like a 401k, unless you do it yourself. There is a way that you can set up your own 401k if you own a small business, but it’s very costly and usually unreasonable. That’s were alternative financial savings tools like IRA’s come in handy.
How’s it work?
An IRA, Individual Retirement Account, shares some of the benefits of a 401k; just not the free money thing. Since you are the business owner, any “matching” contribution would just come from you.
The first shared benefit between 401k’s and IRA’s is the reduction of taxable income for the year of the contribution. In the previous example where an employee makes $100,000, but contributes $3,000 to his 401k, that employee would get to deduct that contribution amount from his income. Therefore, when he calculates his taxes, he will only be taxed on the $97,000.
IRA’s work very similarly in this regard. That’s why you see a lot more advertisements to open an IRA during the first quarter of the year. As people look for tax deductions to reduce their tax liability for the previous year, they contribute to IRA’s and other retirement accounts that let them reduce their taxable income by the amount of their contribution (you can contribute to an IRA for the previous tax year until you file the taxes for that year).
401k’s & IRA’s also both grow tax deferred. This is a biggy. Imagine you have $10,000 saved in one of these retirement plans. If over the next 30 years you could grow that money at an average rate of 7% you would end up with $76,123. Now what if the IRS came in and took 15% of the gains you made each year? The amount after 30 years would drop to $56,628.
That’s almost a $20,000 difference on a $10,000 investment! That’s what IRA’s do, help you keep that 15% each year, and that allows for more compound growth in your IRA. So yes, not having a 401k with a matching contribution sucks, but don’t miss out on the wonderful tax benefits of saving in an IRA.
Do note that there are a variety of IRA option and tax strategies, so be comfortably educated on the topics or get help from a professional when making these plans.
There is too much information about IRA’s to cover in one day, including tax implications, contribution limits, and investment strategies. There is one thing that outweighs all the other factors. It will impact your retirement goals more than anything else. Time.
It’s one survey question everyone already knows the answer to; no one is saving enough for their retirement. I could go into all the cost of retirement to scare you into realizing how much you need to save, but I’ll do that in another post. Today, we will look at some numbers for inspiration.
Let’s revert back to our previous example of $10,000 growing for 30 years at 7%. Since we know the tax advantages, we put it in an IRA and avoid paying taxes each year so the fund would grow to $76,123. These estimates could be pretty similar to someone who started saving seriously in their mid 30’s for retirement in their mid 60’s.
But what if instead of starting in their mid 30’s, they started in their mid 20’s? All other factors staying the same, after changing the time to 40 years, the ending value of the IRA would be about twice the original at $149,745!
Even saving small in the beginning can have a big impact. Starting in your mid 20’s again, you put away just $100 a month and earn that 7% return. If you keep doing that until you are 65 you will end up with $262,481. Now, if you don’t start for another 10 years (in your 30’s), you will have to put away $200 a month just to get to $243,994 by age 65.
Doubling your savings for the next 30 years doesn’t make up for starting 10 years late. Start early and save often, even if it is a small amount.
I hope these examples help put into perspective how significant IRA’s are. If you haven’t started one, create a plan to get one started, even if it’s only a little each month. If you have one, make sure you are making your regular contributions and are confident in its investment strategy.
IRA’s are an important part of a musician’s financial repertoire. Now you have basic idea of what an IRA is and how important it is to your future.